Scotts Miracle-Gro Co (SMG) 2003 Q1 法說會逐字稿

Good morning and welcome to The Scotts Company First Quarter Earnings conference call. All participants will be able to listen-only until the question and answer session of the call. This conference is being recorded at the request of Scotts and if anyone has any objections, you may disconnect at this time. I would like to introduce the first speaker for today's call, who is Rebecca Bruening, Vice President and Treasurer. Madam, you may begin.

Thank you. Good morning and thank you for joining us to discuss our Q1 results for our 2003 fiscal period ended December 28th. As part of our discussion this morning, President and CEO, James Hagedorn and Senior Vice President and CFO, Christopher Nagel, will be providing you with some forward-looking information.

In accordance with the safe harbor regulations, we strongly advise you that actual results could differ materially from our expectations due to a variety of factors. We urge you to read about these factors in today's press release as well as in our SEC filings.

Before we get started, I would like to invite those of you who are interested, to join Jim Hagedorn and others here at Scotts for a day of store visits in March. We are still working out the details, but plan to visit stores in Florida early in the month. Last year, we did our store visits in Ohio in the month of June, so we thought it was important to give you an earlier look at what is going on at the store level in 2003.

In addition to the store visits, we'll host a lunch that day that will include a discussion from members of our sales group who will talk to you about how we work with our retailers and how those relationships have evolved in recent years. If you receive emails from us already, you will be receiving an invitation from us in the next couple of weeks, providing more details. If you are not on our email list, please contact either Jim King or myself and we will make sure that you get invited.

With that, let me turn the call over to our CEO, Jim Hagedorn. Jim.

Thanks Rebecca and good morning everyone. Although I don't think we have day above freezing here in Ohio since New Year's, all of us at Scotts know that the gardening season is right around the corner. Not only are we excited, but in talking to our retail partners, it is clear that they are too. Together, we think 2003 is shaping up to be a great year for the lawn and garden category, which means it should be another record year for Scotts.

Even though it is January, we think our confidence is justified. Why? Because last year's profit and execution has carried over into 2003. This year, we will be implementing several new programs, further leveraging our industry-leading brands, building a stronger sales force, increasing and enhancing our advertising and continually improving our supply chain. Most importantly, we are working more closely than ever with our retail partners in every channel.

Both in our accounts and here at Scotts, the focus this year is very clearly on the consumer, which I view as a very positive sign for the season. All this is coming off our record performance in 2002 and occurring in a year where we are also investing to help ensure the long-term growth of The Scotts Company. I will touch more on these issues in a few minutes, but first of all, I want to hit a few of the highlights from our press release today.

The Q1 results we reported this morning had us off to a good start with company-wide sales up by 12% and North American consumer sales up 11%. Each of our businesses in the US is up on a year-over-year basis. Although it's on a small base, we are encouraged that POS data from our major retailers showed sales of Scotts products to consumers increased 10% in the quarter. As we talk to our major accounts and continue to look at consumer behavior, we remain confident that POS will be strong in all of our categories and distribution channels throughout 2003.

As you can see, our sales growth in the quarter was much closer to POS growth, which is in keeping with what we expect on a go-forward basis. You might recall that this time last year, POS growth was outpacing our sales growth by about a 2:1 ratio as our major accounts trimmed our inventory. We continue to believe that most of de-loading of inventory is behind us.

We also saw continuing improvement in customer service levels during the quarter. This metric speaks of our continued improvement in the supply chain and is an important part of our relationship with our retail partners, important enough to be factored into our incentive program throughout the business.

Michel Farkouh's team in Europe continues to make improvements to our business there as well. Both International and Global Professional made their numbers for the quarter and remain optimistic that both will get their growth targets for the full year.

Additionally, we are off to a good start with our international growth and intergration plan. We continue to expect these efforts will result in the doubling of both international earnings and ROIC by the end of 2005.

We have begun consolidating our manufacturing and operations in Europe, and both Germany and Austria have moved on to a new SAP platform during the quarter. Those of you who have followed companies who have implemented SAP know it is not easy. The hard work of our German and Austrian teams is allowing them to continue hitting their targets while managing this challenging process.

Chris will spend more time going through the specifics of the quarter and providing you with a better understand of what we expect for the balance of the year. Right now, I would like to shift back to some of the issues I mentioned at the outset, which will help explain why we are so optimistic as we enter the season in North America.

I want to start by telling you that it is clear to us that our retail partners are truly looking forward to the start of a long gardening season. Based on recent conversations with some of them, they are more optimistic than we have seen in years. This season, there are no lingering questions about the drought on the East Coast, they believe the harsh winter will lead to a strong start to the season and they are encouraged by continued consumer involvement in the category, even through the fall. Better yet, I don't know that any of us here at Scotts can remember a time where we felt better about our relationship with our retail partners.

Some of you may dismiss the use of the word "partner" as a kind of marketing speak when we are talking about our accounts. You shouldn't. Whilst it has been years in the making, we have seen a much stronger, more open and honest relationship developing with our retailers and we think we can take this entire category to the next level. Why? There are a host of reasons.

Lets start with the investments we have made with systems like SAP and [Manugistics] which has allowed us to vastly improve our customer service. Without a doubt, we have become one of the top performing suppliers for each of our major accounts. In fact, the CEO of one of those accounts, told a group of us here this month, that Scotts have invested in some of the best systems and processes of any supplier in the entire chain in the entire country.

But there is more to it than that. Over the last several years, we have completely overhauled our sales force, our entire approach to sales for that matter. We started three years ago when we consolidated multiple sales forces and adopted a one-face-to-the-customer strategy. It's not like we made that change and then sat on it. We continue to refine the process and ensure we have the right people in place. More important, we put the right kinds of people in place. Let me give you a couple of examples.

A few months ago, we named Barry Sanders as Senior Vice President of sales for North America. He came to us five years ago from [Cap Gemini] Ernst & Young and had the strong background in supply chain management. That background may seem a bit odd for the head of North American sales and you may not know of too many other companies who would put a supply chain person in charge of a sales force. However, the relationship with retailers today is different. Call the old relationship whatever you want, buyer and seller, vendor and vendee, those days are gone. Today, the supply chain is more important than ever in working with our top accounts. Having a guy like Barry in place allows us to develop a stronger partnership by working closely on increasingly sophisticated logistics and replenishment initiatives. In a short period of time, he has already had a positive impact on helping us further strengthen our key relationships.

Another example of having the right kind of people in place is evident in our Business Development Team, which used to be entirely staffed by sales people. Some of you may remember Joe Chief who used to be head of Marketing at Scotts and then ran our out-growing media business, we later asked him to oversee our SAP and limitations. Today, Joe is running our Business Development Team at Home Depot. His diverse background and depth of knowledge of running a business has been invaluable in helping us help Home Depot get more out of their lawn and garden departments.

We believe we are truly being more innovative and creative in helping maximize the productivity of the lawn and garden departments with all of our major retail partners. Our use of in-store counselors is a prime example. This program, which puts our people in the store to answer consumer questions on weekends, has been so well received, that we are doubling our investment in counselors this year and expanding the retail program to other retailers.

Kevin McDonald, Vice President of Field Sales, has done an outstanding job working with our field sales managers, merchandisers and counselors in the DIY channel. Those of you who know me, know I have a military background which is why I find guys like Kevin so valuable. He is the commander of our street force, managing hundreds of people in the field. Kevin's group has raised the bar on the retail floor, giving Scotts a real competitive advantage.

All those things have helped strengthen our relationship with our retail partners. So has our commitment to advertising, which continues to drive more traffic into the stores. Next month, we will break our advertising in the South and it will creep more forward as the weather turns warmer - we hope!

You might remember talking about the increased competitiveness of our advertising last year. This season, we are going to be even more aggressive. For example, our Turf Builder Plus 2 spots will have stronger and more competitive copy than ever. These slots will feature our Scotts products spokesman, Ashton Ritchie, who will tell consumers that Turf Builder Plus 2, which feeds lawns and controls dandelions, is more than twice as effective on weeds as the value-priced brands.

We have reams of data to prove the superiority of our product offerings, but we have not been very aggressive in telling the story in the past. However, product superiority will be an important and ongoing message that we expect will help to continue to grow our market share.

Because consumer response to Ashton was so strong last year, we are planning to use him on other Turf Builder commercials during the season. He will help us advertise MaxGuard, a summer product that is specially formulated to control fire ants and feed grasses like Bermuda, which flourish in the thousands. This product is the more powerful cousin of Turf Builder SummerGuard, which Ashton helped introduce on television last year, resulting in more than a 50% increase in TOS compared to product delivery placed.

As you know, we are planning a 20% increase in advertising this year. Going into the season, a significant percentage of that airtime has already been purchased in the up-front market, and we couldn't' be more pleased with the quality and cost of our buy. We were able to secure a significant amount of prime-time network space for this spring and summer at very attractive rates. The effectiveness of our buy makes us confident we will be able to hit our target of ten billion consumer television impressions in 2003, up from eight billion last year. And history shows a clear correlation for sales growth and increased advertising impressions. Those advertising efforts will have an impact beyond just the big box retailers, especially this year and in the future.

Our new business group, headed by Senior Vice President, Tom [Foyfee], has been reaching out this year to build our presence with the independent trade into expanding into the grocery channels. So far, we have had good successes in both areas.

We expect to see some nice figures this year with independent hardware stores and garden centers. We are working with them on new product lines that are positioned to meet their unique, strategic objectives. We think this effort will provide these retailers with the level of differentiation that is crucial for them to compete more effectively.

In providing this differentiation to them, it will help us build share in this important channel. Discussions between Tom's group and grocery retailers are also progressing well. One of the major national chains has already committed to implementing a full Miracle-Gro Plant Care Center on a chain-wide basis in 2003. We expect to see some more incremental gains from grocery this year and more substantial gains in 2004.

So across all the retail channels, we feel good about the business as we move closer to the gardening season. We enter the season with a better advertising program, stronger sales force, creative programs unique to each channel and continue to make supply-chain improvements that will lead to higher customer service levels.

Let me shift gears one more time and talk for a few minutes about Scotts Lawn Service. Tony Coltrell(ph.) and his group have had another strong quarter and we continue to expect a 60% to 64% top line growth for the full year. That growth will come from our continued acquisition strategy as well as from organic growth in existing markets, which is being fuelled by our marketing programs. More importantly, we are beginning to really see the positive margin impact that this business will have on the company and that impact will be more evident by the end of this year, as Chris will explain shortly.

Like our consumer business, Lawn Service is gearing up its marketing efforts for the season. It recently began its direct mail campaign in the South Eastern market and we expect to send a total of about twenty million pieces of direct mail by the end of the year. We continue to believe that we have the highest response rate to our marketing effort, a higher customer service rate and not surprising, a higher retention rate as well.

Before I turn the call over the Chris, I want to mention some changes in the composition of our board of directors that I think speaks for our serious commitment to corporate governance. You probably saw recently that my predecessor, Chuck Berger has decided to retire as chairman. Also retired from the board is John Kenlon, one of the first employees of Miracle-Gro and someone who played a key role in this company over the past forty years. Both Chuck and John have been great contributors to this company and both deserve tremendous credit for the success we have realized here.

When Chuck got here in 1996, our entire focus changed. Back in those days, Scotts was still considered a chemical company and certainly not a consumer products company. He brought that change with the focus on building our brands and strengthening our marketing efforts. He also served as a mentor for me and I still find lessons I have learned from Chuck on a daily basis.

John Kenlon's role cannot be understated. He was the former President of Miracle-Gro and I would say, one of the founders of that business. He played a key role in working with my father, Horace, in developing a business model that made Miracle-Gro a phenomenal success.

Clearly we owe both of these men a debt of gratitude. I will personally miss their insight and counsel. However, I think we are extremely lucky to have two new board members lined up, who I expect will make an immediate impact on our company.

Stephanie [Shurn] has been chosen to fill the vacancy created by Chuck's resignation. She has a long and impressive background as an auditor in the retail industry, rising to the level of Vice Chairman and Global Director of retail and consumer products at Ernst & Young. She is a CPA, so she will serve on our audit committee and will qualify as a financial expert under [indecipherable].

Also up for election on the Board is Leah Beasley, one of the best consumer marketers in the world. She is the President and COO of RJR Tobacco and has spent her entire career marketing branded products to consumers. I believe she will also make an immediate impact on the board.

I think it is also worth noting that the transition on the board results in replacing two insiders with two independent members. On our 12-member board, we will have only three people who could not be categorized as independent, under today's more rigorous standards: myself, my sister Kate Littlefield and Pat Norton, our former CFO.

With that, I want to turn things over to Chris. This is his first conference call with all of you after taking over the CFO role from Pat on January 1st. Chris has been with Scotts for four years and was previously CFO of our North American business, a role that gave him exposure to the operating side of the business. He was Interim CFO prior to Pat's arrival and then served as Corporate Controller. Before coming to Scotts, Chris was CFO for Borden Chemicals and started off his career in public accounting with PWC. He has obviously got great financial background and he knows this company as well as anyone here. We are fortunate to have him in this important role. Chris.

Thanks Jim and good morning everyone. Because the first quarter is such a small part of the year, I am not going to spend quite as much time in going line by line through the financial statements, but instead just hit the major highlights. I also want to spend some time talking about the remainder of the year, especially discussing our anticipated quarter-by-quarter results. This includes a fairly significant shift in the timing of some expenses that will result in lower second quarter earnings, but significantly improve the earnings in the third and fourth quarters when compared to prior period.

In my discussion this morning, where relevant, I will seek to resolve and exclude the impact of foreign exchange because there has been a significant shift in exchange rates from the same period last year. For example, when compared to the Euro or British Pound, the dollar has weakened over 10% quarter over quarter. With those comments, lets move on.

As Jim mentioned earlier, company-wide sales, which represent less than 10% of anticipated 2003 sales, were up 12% from last year to $181m. However, excluding the impact of foreign exchange, sales increased 8% from the prior period. Our North American consumer business was the biggest component of that increase, with sales of $85m, an 11% increase from last year. The increase in sales was enjoyed not only in all major business shares, but across all of our major retail customers as well.

Scotts Lawn Service was up $6m to $15m for the quarter. The increase in sales reflects both organic growth and the benefit of recent acquisitions.

International consumer was up nearly 8% to $43m and Global Professional was up 3% to $38m. However, excluding the impact of exchange rates, both of these businesses reported slight declines in the quarter, due to the continuation of the trend of shipments moving closer to consumer take-away or customer needs. We remain confident that both businesses will meet their full year targets.

For those of you who are familiar with our overall guidance for the year, will remember that we expect gross margins to improve two hundred basis points this year. We began to see the improvement already in the first quarter, as gross margins increased to 20.6% from 19.3% a year earlier. The improvement is due to supply chain cost reductions, the favorable impact of Scotts Lawn Service and foreign exchange rates, offset by higher restructuring costs. In fact, exchange rates accounted for sixty basis points of improvement in gross margins this quarter.

In round up, we had a net expense in the quarter of $7m. Remember our commission in this business is based on a percentage of profits. Although that profit threshold won't be crossed for several months, we continue to believe that $10m in net commission is an appropriate assumption for the year.

Advertising was nearly $9m this quarter, or 4.8% of sales, up from 4.4% last year. Remember that we expect advertising to be about 5.1% of sales this fiscal year, which is higher than last year, due to our planned 20% increase in advertising.

SG&A, excluding Scotts Lawn Service and restructuring, was down slightly from the prior period. On a full year basis, we expect SG&A as a percentage of sales, to be higher than the prior year, due to our planned investments as Jim mentioned earlier and I will discuss later, how these investments impact quarterly earnings for the remainder of the year.

EBITDA, adjusted to exclude restructuring and other non-recurring items, was a loss of $41m compared with the loss of $45.4m last year. Including restructuring and non-recurring items, EBITDA was a loss of $47.3m, about flat with last year's unadjusted number.

Interest expense was $16.5m, a $2m improvement from last year. Our significant free cash flow in fiscal 2002, allowed us to decrease average debt in the quarter by $117m from last year to $864m. Those improvements translated into an average net debt-to-EBITDA ratio of 3.06, a significant improvement from 3.8 a year ago. Interest coverage also improved again to 3.8 from 3.0.

Depreciation was $8.7m and amortization was $2.8m. Capital expenditures for the quarter were $18.6m.

Bringing everything to the bottom line, our loss for the quarter, excluding restructuring and other charges, was $42.9m or $1.42 per share, compared with the loss of $46m or $1.60 per share last year. Please note that shares outstanding for the quarter have increased $1.4m compared to the prior period, which had a favorable impact on the loss per share of 7 cents.

Including $3.9m for restructuring and other charges on an after-tax basis, the net loss for the quarter was $46.8m or $1.55 per share, compared with $65.4m or $2.27 per share last year.

Prior year results include restructuring and other charges of $900,000 and an $18.5m impairment charge related to foreign and tangible assets, all net of tax.

Let me move onto the balance sheet for a moment. You see that accounts receivable are up slightly from the prior year, but less than the increase in sales. The balance continues to reflect a good story from the last fiscal year, the quality of our receivables is increasing and our delinquencies are decreasing.

Inventories were down 12% or $57m compared to the prior period, reflecting the continuation of our emphasis on reducing inventory levels.

Now I would like to shift my focus onto the rest of year and help you understand the guidance we outlined in the press release this morning. When we provided guidance in our analyst's meeting last November, we told you we expected the timing of our projected 7% to 9% increase in consolidated sales would closely mirror 2002. That is still the case.

However, we also told you that we were unsure at the time how the phasing of our increased investments would impact our earnings from quarter to quarter. We now have a better understanding of when those expenses will impact quarterly earnings for 2003.

I want to preface these remarks by reminding you that we are reaffirming our full year earnings guidance, so the projections we gave you last November were on a full year basis for margins, SG&A, interest, depreciation, amortization, taxes and share capital are still valid.

If we look at the second quarter, on an adjusted basis we reported a net income of $65m in the prior period. For 2003, we would expect that number to decline in the range of $4m to $8m. The reason for the second quarter decline in net income, is due to a variety of factors.

Firstly, the investments we outlined earlier, or more specifically, investments in our new business development group, North American sales force, information services and research and development.

Secondly, because of the timing of when certain supply chain cost-savings were realized last year, we will likely see a slight temporary decline in gross margin as a percentage of sales in the second quarter.

Thirdly, as Scotts Lawn Services continues to expand its operations, the seasonality of the business results in larger losses early in the year and a higher contribution to our profits in the second half of the fiscal year.

In the third quarter, we would expect to see a $6m to $10m improvement in adjust in net income from the $95m we reported in 2002. We should see a nice gross margin improvement in the quarter due to North American and international supply chain savings, partially offset by the continuation of the investments we described for the second quarter.

In the fourth quarter, we see an improvement of $8m to $12m from the adjusted quarterly loss of $10m that we reported last year. The big driver at the end of the year should be in gross margins. We expect to see some significant margin improvements from warehousing and logistics savings in North America. In addition, the growth of our Scotts Lawn Service business will contribute to an increase in the company's overall gross margin percentage. The impact of this important business is particularly noticeable in our fourth quarter, which is the most significant quarter for this business, in terms of both sales and margins.

Shifting to free cash flow for a minute, I would like to discuss our full year guidance. As you will recall, we reported free cash flow for fiscal 2002 of $161m. Last November, we indicated that we are expecting free cash flow of $85m to $105m for fiscal 2003. However, after discussions with many of you and our rating agencies, we are making a small change to how we calculate free cash flow.

Beginning fiscal 2003, we will now deduct all cash payments made in connection with our Lawn Service acquisitions. In the past, we only deducted from free cash flow, the cash payments made on Lawn Service acquisitions made in that year, excluding payments made in the year on prior years acquisitions where a portion of the purchase price had been deferred. The deferred portion of a purchase price had been included in the company's total debt, to be repaid from free cash flow. Given the ongoing nature of our Lawn Service acquisitions, we believe this change is appropriate and a conservative way to determine free cash flow we have available to pay down bank debts. Applying this new methodology, changes our estimate of free cash flow for the current fiscal year to a range of $65m to $85m.

It is important to note that we are not changing our overall expectation of free cash flow for fiscal 2003. The change from $85m to $105m to $65m to $85m for year, is due to the change in methodology only. It should also be noted that free cash flow for fiscal 2002 would have been $151m under this new method.

Jim spent a lot of time this morning talking about our optimism for 2003 and I think our financial outlook merits that optimism as well. Hopefully the discussion today helps you to better understand why we remain confident that we will see company-wide sales growth of 7 to 9% and adjusted earnings growth of at least 15%.

With that, I will turn the call over to the operator, so we can answer your questions.

Thank you. At this time, we are ready to begin the question and answer session. If you would like to ask a question, please press star 1 on your touchtone phone. You will be announced prior to asking your question. To cancel your question, you may press star 2. One moment please.

Our first question comes from Mr. Jim Barren of Caine Associates. Please go ahead sir.

Good morning everyone. Chris, have you hedged your foreign exchange rates at all?

Not explicitly. Despite the big movement in our FX tax rates, because of the relatively low profitability of our international businesses right now, we still really don't have much of an exposure on the bottom line, so we are likely to see some movement in the line in the profit and loss. Bottom line impact should be rather minor. So on a transaction basis, we try to settle those things fairly quickly so that we don't leave ourselves exposed on an FX basis, but on a translation basis, I think the earnings impact should still be small for the year.

Thank you.

The next question comes from Mr. Joe Norton of Bank of America Securities, please go ahead sir.

Thank you and good morning. I have a couple of questions. Firstly, in terms of the guidance on the second and the fourth quarter in particular, I was wondering if you could go into a little bit more detail on the second quarter, I wanted to be clear, are these one-time costs largely that we are not going to see continuing in the third and fourth quarters, or is it going to be more driven by the cost-saving in the margin that you talked about for the year-over-year issue on this? I am not clear why [inaudible].

Let me just go to Q2 and what is driving that. A bunch of these investments that we are making in the future of our business, which we call channel and category development. Channels means new retail channels like grocery, the independent side of the business. Categories relate to pottery, tools, that sort of thing. We have a bunch of people working there and part of it involves programs for our independents and part of it as people, but in the early years. One part of me, Jim Hagedorn is saying, it is relatively one-time, we just don't have much income, we have the expense now, so I don't view it as a recurring issue and our expectations right now is that they will pay this way going forward.

We are going to ramp up the spending in Q2. It is not a one-time in Q2 relative to the remainder of the year, but when you put that in combination with the slight decline in margins that I described and the impact of Lawn Services in Q2 that I also described, you will just end up getting a fluctuation of year over year comparisons of net earnings. Does that help?

The next question comes from Mr. Joe Altobello of CIBC World Markets. Please go ahead sir.

Good morning. Just a couple of questions. One, a bit of feedback on the last question. Could you quantify how you will be spending on incremental things this quarter and how that compares to what you have been saying last year as far as spending on new initiatives over the next couple of years? Also, on the free cash flow side, are you still relatively confident that the free cash flow you are going to generate over the next eighteen to twenty four months is enough to get you where you want to be as far as balance sheets are concerned?

When you said what we got supervised before, I am not sure that we have that information, these investments are going to be new for 2003, so the investments and the business development team, the North American sales force, investments in IS projects to support long-service for instance, these are all several million dollars. You are talking about investments that all total in excess of $10m when compared to the prior year.

Part of that spending in the second quarter is going to be in Europe as well, right?

These are expenses that are just hitting the base profit and loss, these are not restructuring expenses in connection with the European immigration plan, these are investments we are making basically to the North American business.

Okay. You said that is probably north of $10m for the quarter?

Correct. Your question on free cash flow--Let me say it another way. I think we are very confident that these levels of free cash flow-- we are still dedicated, our primary objective with that free cash is to pay down debt and we are very confident that the continuation of this trend is going to really get us to the place we want to be from a capital structure standpoint. There is no real change in our thinking yet.

If you look at the way we defined cash flow last year, it is not tremendously different this year. We are talking about a quarter of a billion dollars of free cash flow over a two year period. Do we think that is satisfactory to improve our balance sheet? Yes. Do we feel like we need to go out and do an equity offering, which people have been asking? No.

That incorporates the acquisitions on the long-service side as well?

Yes.

Joe Norton, I don't know what happened there, but if you are still on the line and you had any other questions, just queue up again, we'll make sure they get handled. Next operator.

Mr. Norton, you may ask your question.

Oh! Sorry to give you the heave there, I don't know what happened!

I guess I better ask a different question!

Did we answer your first question fully?

I think so, although I just wanted to follow up on the fourth quarter as well. It is sounding like you are projecting that basically you could break even in the fourth quarter, which is a pretty significant improvement. I just wanted to get a little more color on what your confidence level is.

A lot of it is driven by two things, a significant improvement in gross margin in North America, it is really where we are forecasting to see the large benefits of this year's initiative in supply chain, particularly on the warehousing and logistics side. The gross margin in North America is going to increase substantially in that quarter year over year. Secondly, the growth in the Lawn Service business year over year, will have a very significant impact on the profitability, so the combination of those two things should put us to a point where we are basically breaking even, we are making income in Q4.

Thanks. Moving onto the Lawn Service a little bit, am I correct in assuming that we benefited from three acquisitions during the quarter last year, or is it just two, I am sorry, I can't remember the timing exactly of those acquisitions?

We are going to put Tony Coltrell(ph.) on to answer you.

Good morning. We actually benefited from a number of acquisitions, many of them were fairly small, but we also had three large pieces of businesses we acquired last year, starting in late January that obviously were not a part of our business in our fiscal first quarter. We acquired a bunch of business from Centex, their lawn care division, as well as a company called Long Company and K.C. Earlex Care Division, which is primarily in Eastern Pennsylvania and Philadelphia.

Okay, so all of those were not in the numbers last year, correct?

Correct.

Right. Can you point out the organic growth rate of the business excluding acquisition?

Its roughly 50:50 year-over-year increase.

Okay, and so is the first quarter the lightest Lawn Service quarter?

The first and second quarters combined only represent about a quarter of our year's sales, slightly over a quarter. Therefore, the majority of the sales will really kick in on the third and fourth quarters, as has been the case in prior years as well. We have a little bit more sales in the first and second quarters this years because of the addition of our business in the South, but nonetheless, it is still largely a spring and summer business for us and then things start to wind down a little bit.

Your fiscal fourth quarter is the largest?

Yes.

Can you update us at all on acquisitions, should we--

I'm going to pass this back and maybe try to push the call forward, but we don't want you to unhook again!

We are doing the same string of acquisitions that we've committed to, which is roughly $30m a year is what's Tony's blanket authorization is, from me and the Board. Remember, these are relatively small acquisitions. $1m, $2m, those are pretty standard, but you are talking about an acquisition we could be involved in, it is pretty busy so that is how it works and it is what we did before and we will continue this way. If something big comes along that is interesting, we will talk about it and take it to the Board.

Thanks.

The next question comes from Mr. James Howard of National City Bank. Please go ahead sir.

Good morning gentlemen. A couple of questions on advertising. Have you changed the timing because of what is going in the emphasis on the quarters as far as the timing of advertising going forward? I hear you've done most of your purchasing of advertising time for this year and you are pretty well committed. How is the cost of it running compared to what you expected?

I'm going to pass you over to Bob Stohler, but we buy advertising when we think consumers will respond to it, which has nothing to do with our quarters, its all to do with the natural seasonality of our business. A lot of our buying is already done and we have got really great rates, because you might recall that the fall was a pretty tight time as far as cost of media compared to the year before. Our up-front by the spring was that basically roughly the same cost per thousand, as it was the year before, so Bob, do you want to handle this?

About three quarters of our national television buy is completed. We also do local radio and we do some spot-buying and that is not necessarily all done. We are pretty pleased with rates, within reason, they reflect the kind of rates we paid last year, so on a per thousand basis, we feel pretty good. Importantly, we also have the quality of programs that we wanted to have, which we think was instrumental in our success in fiscal 2002.

Thanks Bob. Any other questions?

You mentioned the Ashton Ritchie stuff going forward. Does that imply that there is going to be even more emphasis on gardens going forward on the advertising side?

Your question is on our Lawn Service side. I am going to say somewhat of a transition in our advertising strategy in lawns, which was 100% neighbor-to-neighbor and we really liked how Ashton did last year. That was the first time he has been on television, he has been a radio personality. This is a guy who came up from research and development and worked in our SAP implementation and marketing hooked on to him as a regular guy with a great voice, who is a really nice guy by the way. He sold really well last year, so we are including him more and we like the fact that when we get really competitive in the spots, it is hard to do that with neighbor-to-neighbor. It is a lot easier when there is someone who is viewed as knowledgeable and I am talking about why a product out-performs another product. We like that-- Bob is sending me a note saying basically new products or Ashton and the old products, we are sticking with neighbor-to-neighbor.

There was a fairly substantial increase in advertising in gardens in the large part because the Peter Strauss campaign we feel really good about and a lot of that media was focused against maybe our fastest-growing consumer non Lawn Service business, which is our Growing Media business. I don't see anybody in here from Growing Media, but they claim that in two years, they will be the most profitable business in the entire company. It tells you how they feel about how a business is turned from a commodity business to a very high margin and fast-growing consumer category for Scotts and so the Peter Strauss advertising will continue to be funded heavily.

The next question comes from David Cumberland of Robert Bear. Please go ahead, sir.

Good morning. Jim, you talked about retailer relationships. Are you getting store sets in January as expected for some retailers? Also, could you comment on the impact of the cautious sales outlook for Home Depot and also your view on the fact of K-Mart store closings.

The store sets, yes we are seeing earlier store sets in Wal-Mart. The earlier sets are going into Wal-Mart, which is a good thing. That shows again a commitment to lawn and garden and enthusiasm for the 2003 season.

Your question about Home Depot-- Barry, let me start, but I can see you're eager to go! I look at the cautious words that are coming out of Home Depot and people's concern. From my point of view, this is not like a [butt kissing] part of a call where I am trying to say something to Home Depot. Home Depot has been going through a very introspective period of their lives. As they change culture and are putting systems in, there are a lot of things they are doing that become bigger boys, instead of being adolescents, they learn to be adults in a corporate sense.

We went through that same sort of thing here a couple of years ago when we were putting in SAP and going one-face to the customer. We did a lot of stuff and we weren't particularly consumer-orientated when we were going through the SAP and reorganizing the entire company and not making our numbers in Europe. My view was that a lot of that is in past tense. The relationship we have with the merchants at Home Depot, I see the programs, I see what people want to offer and what people offer us back and the "to and from" that takes place and the annual negotiations as we look to see how we can sell more stuff to the consumer.

The programs we have to put together with Home Depot in my view, are the best we have ever had with them and the attitude of the team of merchants there, is excellent and I think our relationship is as good as anything in the entire company. I think a lot of this is a last-year issue and it is not to say that all of their problems are behind them, but I do think that they are going through changes and from my point of view last year, I was more concerned about some of our relationships and how much they were paying attention to lawn and garden and this year I think they are looking forward now and from my point of view, that is very positive. Barry?

I was in Florida yesterday and I went to several stores. The things I would say about them is that the stores are set, they look great and probably of equal importance, I talked to several of the store managers and department managers and they are excited about the season, they are ready for lawn and garden and they think they are going to have a great year. This gives an indication of how the chain looks and it looked fantastic yesterday, so I am pretty excited and our sales people think its going to be a great year.

Thank you. My last question was about K-Mart.

I would say they closed more store stores than we thought, we thought we were being conservative in our plan, for those of you who came to our analyst meeting in November, we showed how we looked forward and closed doors was one of the things we thought we were being conservative about, but we slightly underestimated the number of closures, but I asked Bob if he was concerned about the impact and the effect on his numbers and he said no. While he was somewhat surprised about the number of stores that closed, he has not expressed any concern about his numbers for the year.

Thank you.

Our next call comes from Michael Millman of Solomon Smith Barney. Please go ahead sir.

Thank you. I will ask my questions in advance, in case the trigger finger gets itchy again! Cash flow, could you give us some of your working capital assumptions regarding free cash flow for this year and any particular inventory and caps receivable.

Also, in trying to get more flavor to these timing changes, are you talking about moving up expenses or moving up some investments that would have made in the third and fourth quarters and therefore you are going to be getting some benefits earlier, or are you saying that these are one-time start-up costs that would have been in the third and fourth quarters and have been moved up?

Another question, you talked about the improved margins at SOS, can you tell us what they were in the first quarter? What do you expect them to be for the year and what they were last year?

Typically, your working capital tends to peak in this quarter. Could you tell us what you expect that peak to be, what it was last year and if the decline is strictly caused by the amount of cash that you had on hand or are there some other things involved?

We don't have a problem talking to anybody, I think we have got all the material information out, so again if you don't get everything, you always know you can call us. I'm going to start with the timings, which I am going to do in a different format. My view is that we are not going to save our way to success in this business. Part of what we have to do, is to grow our business and that is going to require investment and we should be willing to make that investment if we believe the return is adequate.

The independent business is really important for us. We do not want to become a three-customer company and we ought to have market share and independence and hardware equal to our assets and so we think that is an important job for us and I felt that we needed to have a separate group of people working, our independent and garden center group, because what we found is that people act the way they talk and if we talk big four all the time, if you are not in the big four, you are not getting the same quality of resources and so Tom's group is now responsible for this independence in hardware, food, drugs channel. That required us to make some adjustments to programs to help them be more competitive and it requires good people, because did not hire a lot of people from outside. We basically took people out of our existing business and moved them in here, so some of these costs are incremental and others were always there. We have added some people and program costs are incremental.

I do view it as a start-up myself, other people may view it differently, but I see it as Tom starting a new business, but I don't see it as us having moved it up from Q3 to Q4, we just needed to say we are going to invest in our business to drive these categories and channels and you know how this business is. If you want to be sitting down in front of merchants this coming May, you better have this work done now. This is just work that has to happen in 2003 in order to make the sale for 2004. I don't view it as a timing issue of moving it up or backwards or anything like that, its just if you want to have programs ready for presentation to retailers this spring/early summer, you best have them worked on now. I am going to ask Tony to come over once again and try to answer those questions on margins.

We don't give margins out by our business, what we can say, is that gross margin for the Lawn Service business is consistently stronger than the averages for the rest of our business, so even though in the first quarter, the margin for Lawn Service is not what it is in the latter half of the year, but it is still ahead of the margins we enjoy of the remainder of the rest of the business in the quarter. You see a delta between Lawn Service margins and the rest of the business throughout the year, but this is a relatively low quarter for Lawn Service both in terms of volume and gross margin findings.

Let me move on to free cash flow and the working capital assumptions for the year and our build in the quarter. Last year, we generated a lot of free cash flow as you know and took a lot of money out of the balance sheet, particularly inventory. That was a one-time sizeable correction to the balance sheet. We are going to continue to take some more inventory out of the balance sheet in 2003, although as not as sizeable as we did in 2002. That improvement in inventory in 2003 should also offset the natural build that would come from working capital just from the growth of the business. I think we are going to see a very modest invest in working capital on the year overall, really the result of this improvement in inventory helping us offset the working capital required to grow the business.

Looking at the first quarter, the line profit looks very similar to the prior year, the actual amount manufactured and produced this quarter is probably a little bit different than the prior year because during the prior year, we came into the year with a lot more inventory than we came in this year, so the shape of line looks very similar, although probably just a delta on that line. Timing and shape is very similar, we are building inventory right now.

Thank you.

The next question comes from [indecipherable] of Monarch Capital. Please go ahead sir.

Thank you, good morning, I have two questions. Firstly, how correlated your sales are with housing stocks and housing sales? Secondly, in discussion, I would be interested in exactly why Scotts were sued in Henson -v- A.P. Green Industries back in January 2001. There is a comment here, I assume it has to do with the vermiculite in some of your products. I understand it was dismissed without prejudice, but can you give me the nature of the lawsuit and what exactly occurred?

Housing stocks. We try to take a look at our sales, lawn and garden category sales, gross domestic products, home improvement products and say is there a correlation, is there any way we can know what is happening with the DP or housing stocks, is the relationship with our sales. We can't say none, but I guess you would say some. Bob is very interested in trying to find correlations between other indexes and our sales, Bob do you want to talk about that?

We are not going to provide this morning a correlation full efficient and a projection of that. There is no question that when the housing market is strong, which as you know it has been from the most recent numbers. We benefit from that and there is probably a lag from housing stocks to when we see it impacting our business. When somebody builds new house and moves in, probably the first thing they do is make sure that they have window coverings, they do things to their floors etc. and it may take them six months to a year before they start spending on the gardening, landscaping etc., It is pretty obvious that that is a positive thing on our business, but I would point out that we believe there is a lag.

These could out-perform these indexes by a couple of hundred basis points. We have gone back and charted as many different indexes as we could and the lawn and garden industry has always performed, at least in the history, say five to ten years, over that period, has always performed two to three hundred basis points better than the industry, better than these indexes. Dave, do you want to deal with this litigation question?

We were named in a lawsuit in California in 2001. During the course of that discovery, the plaintiff chose to dismiss that lawsuit based upon the facts and they are basically as follows. Unlike even the most peripheral asbestos defendants, the big three auto-makers for instance, Scotts has never used asbestos in any of our products. Second, over the last twenty years, we have conduced extensive testing of the finished goods that we send out to consumers and all of those tests have shown that our products are finished goods and asbestos-free. Third, our asbestos-free products are encapsulated in a fertilizer glue and their products are used outdoors in any event. So the conclusion is that the plaintiffs in this case realized that there was no case there and that was the end of it.

Thanks Dave. Next question?

The next question comes from Dave Schwizer (ph.) of Shankman Capital, please go ahead sir.

Good morning. You outlined in your opening remarks, expectations and gross margin expansion of about two hundred basis points. While some of that improvement has been driven by higher margins coming from long services and supply chain improvements, I am wondering what your expectations and assumptions are with respect to raw materials, in particular, urea, or any other raw materials impacted by high natural gas or high oil content.

Okay, I am going to ask Michael Kelty, who is Vice Chairman of Scotts. Mike?

You are right, we keep a close eye on natural gas because it does heavily influence urea ammonia to our big feed-stocks as well as a lot of the resins that we use in our packaging. Each year, we have a decision to make, how much do we go on the market and how much do we contract. This year was the year that we decided to contract as much ammonia as we possibly could and those key raw materials. I believe we have made the right decision and I do not foresee any great risk in debating the cost of raw materials.

Do you have a percentage about how much is locked in to those raw materials for the year?

A very high percentage. Also, bear in mind the bulk of our production for the year starts in October and goes probably through March or April, so we have probably got about 60% of our manufacturing done.

Okay. You also mentioned acquisition, you are spending about $30m of acquisition in the Lawn Service business. I am wondering how much was acquired in the December quarter or just total acquisitions in the December quarter?

About $5m or $6m in that quarter.

And $9m totaled so far up to now?

A couple of million so far in this quarter, plus about another $5m or $6m in the first quarter.

Okay great. My last question, you talked in the past about reducing debt and ultimately achieving investment grade ratings. I am wondering what your timetable is for getting to that call and what matrix the rating agencies have told you that you need to achieve in order to get to that call?

You're asking a loaded question, because when I get into fights with the raters - if you're listening, don't get mad at me guys! I think they take you down really fast and they like take you up really slow and I think if this company pays a quarter of a billion dollars in debt in two years, there is no justice if we don't get upgraded. Based on our view of certain nearer investment grade to investment grade as being where we want to be. Based on our strategy plan, we plan to present to the Board next week, 2003/2004. Lots of things change in the plan, depending what the Board says, but that is where we are at.

Okay, very good, thank you.

This will be our last question for the morning please.

Our next question comes from Carla Costello of J.P. Morgan. Please go ahead madam.

My question relates to round-up-- there was an article about the professional round-up business and its effectiveness. I wonder if you are seeing any reduced effectiveness in the consumer round-up products.

I read that article with a lot of interest. What is weird about it is, resistance to round-up is built, if not through biotechnology, it is just through natural selection, i.e. some plants that are already tough to kill, there are plants that survive a string of round-up, if they breathe, they then become more resistant to round-up. This is through natural selection, not through biotechnology. As far as I am aware, we aren't seeing resistance on the types of plants that are generally attacked, which are your standard weeds plus grasses, that's what tends to grow if there are cracks and crevices that people see in their driveways and patios. I am not aware of dandelions that have become naturally resistant or other standard weak stock.

Jim you are right, for the last twenty five years it's been the most widely used herbicide. You're going to encounter certain instances, small populations of plants that would have either natural resistance or perhaps mutated to resistance. Frankly the instances have been very, very low. We have never seen in a lawn garden or the ornamental environment.

This is an important point. Because the agricultural guys at Montano are using pure [glycosate], because their round-up ready crops require them to use pure [glycosate], remember that consumer round-up today is a combination of various actives that provide a much quicker kill which consumers want. Remember, somebody goes out, if they use old round-up, it might take a week or two before they see a response. Today, it's a day or two before they see a response and that means that there are more herbicides in round-up today, more active ingredient herbicides than just [glycosate], it is less of an issue for us because we are not depending just on [glycosate].

Are you renegotiating the contract at all with Montano?

We like that contract and they like that contract, because we are driving that business for them and it isn't like we are making a ton of money on it.

Great, thank you.

This concludes this question and answer portion of today's conference and I would like to turn the call back to Ms. Rebecca Bruening.

Thanks again to everyone for joining us and we look forward to those of you who are interested in seeing and speaking with us on our store visits in early March and look for the details soon to be coming out hopefully in the next couple of weeks. Thanks and good morning.